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Espey Mfg & Electronics Corp. (AMEX:ESP), which has zero-debt on its balance sheet, can maximize capital returns by increasing debt due to its lower cost of capital. However, the trade-off is ESP will have to follow strict debt obligations which will reduce its financial flexibility. While ESP has no debt on its balance sheet, it doesn’t necessarily mean it exhibits financial strength. I will go over a basic overview of the stock’s financial health, which I believe provides a ballpark estimate of their financial health status. Check out our latest analysis for Espey Mfg. & Electronics

Is financial flexibility worth the lower cost of capital?

Debt capital generally has lower cost of capital compared to equity funding. However, the trade-off is debtholders’ higher claim on company assets in the event of liquidation and stringent obligations around capital management. ESP’s absence of debt on its balance sheet may be due to lack of access to cheaper capital, or it may simply believe low cost is not worth sacrificing financial flexibility. However, choosing flexibility over capital returns is logical only if it’s a high-growth company. ESP delivered a negative revenue growth of -18.02%. While its negative growth hardly justifies opting for zero-debt, if the decline sustains, it may find it hard to raise debt at an acceptable cost.

Can ESP pay its short-term liabilities?

Since Espey Mfg. & Electronics doesn’t have any debt on its balance sheet, it doesn’t have any solvency issues, which is a term used to describe the company’s ability to meet its long-term obligations. However, another measure of financial health is its short-term obligations, which is known as liquidity. These include payments to suppliers, employees and other stakeholders. With current liabilities at US$3.38M, the company has been able to meet these obligations given the level of current assets of US$33.23M, with a current ratio of 9.84x. Though, anything above 3x is considered high and could mean that ESP has too much idle capital in low-earning investments.

Next Steps:

ESP’s soft top-line growth means not having any low-cost debt funding may not be optimal for the business. As an investor, you may want to figure out if there are company-specific reasons for not having any debt, and why financial flexibility is needed at this stage in its business cycle. Keep in mind I haven’t considered other factors such as how ESP has been performing in the past. I suggest you continue to research Espey Mfg. & Electronics to get a more holistic view of the stock by looking at:

To help readers see pass the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price sensitive company announcements.

The author is an independent contributor and at the time of publication had no position in the stocks mentioned.